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Wednesday, September 20, 2006

Oracle Victory Lap

By William Trent, CFA of Stock Market Beat

Oracle shares rose more than 9% after yesterday’s close on a strong earnings report.
The Redwood Shores, California-based company said database and middleware new license revenue gained 15 percent while services revenue rose 33 percent to $846 million.

“We exceeded our guidance on every metric and delivered strong revenue growth across all product lines and geographies,” Oracle Chief Financial Officer Safra Catz said in a statement.
The results come as investors are beginning to embrace the company’s decision to spend some $20 billion over the past three years to push into the market for business applications as its core database software market matures.

We were early embracers of the company’s consolidation plan, and are glad to see the results so quickly. Back in March we knew what to look for, just not when to look for it:
The software industry had too many companies chasing too few dollars, and balance sheets too strong to cause any competitors to bite the dust. There is only one way to fix that situation, and that is for an industry leader to soak up the excess capital by leveraging its own balance sheet to acquire other companies - for cash, not shares. Oracle has been pursuing that fix, beginning with the PeopleSoft acquisition and most recently with the buyout of Siebel Systems.

The problem with this fix is that it takes some time and during that time the largest rival, SAP, has enjoyed an easy road. Oracle is busy making and selling product, but also integrating the acquisitions. SAP only has to focus on the core business. Given the short-term horizons of many investors, it is easy to see why Oracle shares are stuck in neutral. So the next question is how to know when to become more bullish. One way is to take cues from the market. There will likely be a point in the next year or so at which the same type of mixed news that caused a selloff today will spark a rally. That will suggest that the market has become comfortable with ORCL’s strategy and believes the worst is over.

We also noted that the positive surprise in June could be the signal investors were waiting for.

A slowing economy could put a damper on things, so it is too early to say for sure whether this is the turning point for Oracle shares. But if they can manage to string together two or three quarters that are even close to this performance, it will be.

With the second quarter now in, investors are voting that it was the turning point. Now, if only SAP would get with the program the whole industry could come up roses. For now, though, it looks like Oracle is on its own as far as consolidating the industry. The good news for investors is that the remaining acquisition candidates will look bite-size now that Oracle has soaked up the biggest game. That makes them easier to pay for and easier to integrate, which all means it will be easier for Oracle shares to stay in gear.

The author may hold a position in the securities discussed. A current list of the author's holdings is available here.

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